On October 14, 2008, the U.S. Department of Treasury issued interim guidance regarding the executive compensation restrictions under the Emergency Economic Stabilization Act (EESA) that apply to financial institutions participating in the Troubled Asset Auction Program, the Capital Purchase Program and Programs for Systematically Significant Failing Institutions. For more information, click here. The type and level of executive compensation restrictions vary significantly among these programs, particularly with respect to severance benefits. None of these restrictions apply to entities that do not participate (directly or indirectly) in one of these programs. However, these restrictions may stimulate further legislative efforts to reform executive compensation and may influence institutional shareholders, corporate governance firms and proxy solicitors in the coming months. As a result, it is reasonable to expect that compensation committees will be asking in the coming months whether some of these changes would be appropriate to extend to companies that are not participating in these programs. Financial institutions may generally rely on this guidance as of the effective date of EESA (October 3, 2008).
Troubled Asset Auction Program (TAAP)
Financial institutions that sell more than $300 million of troubled mortgage related assets through auction sales (or a combination of auction sales and direct sales) to the Treasury Department (TAAP Participating Institutions) are prohibited, while participating in TAAP, from entering into new employment agreements providing golden parachutes to senior executive officers (SEOs) (Section 111(c) of EESA). Notice 2008-TAAP provides guidance regarding this restriction, including how to determine the following:
- Who is an SEO (generally the CEO, CFO and the three most highly compensated executive officers other than the CEO and CFO); these rules will likely be difficult to apply in practice and financial institutions are directed to use their “best efforts” to identify SEOs
- Which financial institutions are covered by this restriction because of controlled group rules
- What is a golden parachute payment (generally payments by reason of involuntary termination from employment or in connection with a bankruptcy filing, insolvency or receivership that exceed limits under Section 280G prior to EESA using the employment termination date as the change in control date)
- What is a new employment contract subject to EESA
- When the buyer of a TAAP Participating Institution becomes subject to this restriction
In addition, a TAAP Participating Institution (whether publicly traded or privately held) may not deduct executive compensation in excess of $500,000 or golden parachute payments to SEOs, and any golden parachute payments will result in a 20 percent excise tax to the SEO (Section 302 of EESA). Notice 2008-94 provides guidance regarding these restrictions under Section 162(m)(5) and Section 280G(e) of the Internal Revenue Code, including how to determine the following:
- The period that the $500,000 deduction limit applies to a TAAP Participating Institution
- What types of compensation are subject to the $500,000 deduction limitation
- When deferred compensation earned from a TAAP Participating Institution will be subject to the $500,000 deduction limit
- What is a golden parachute payment (which is generally defined in the same manner as described above)
The guidance changes longstanding rules under Section 162(m) and Section 280G with respect to TAAP Participating Institutions as follows:
- The performance-based compensation exception is not available when applying the $500,000 limit.
- An executive never loses status as an SEO regardless of subsequent compensation levels and employment status, and nonqualified deferred compensation will be subject to the $500,000 limit.
- The reasonable compensation exemption under Section 280G is unavailable to exempt amounts from being a golden parachute under Section 280G(e).
Capital Purchase Program (CPP)
Financial institutions that participate in the Capital Purchase Program (CPP Participating Institutions) are subject to more onerous executive compensation restrictions during the period that the Treasury Department holds a meaningful debt or equity position acquired under this program. These restrictions include (1) limits on incentive compensation to ensure that SEOs do not encourage CPP Participating Institutions from taking “unnecessary and excessive risks,” (2) required recovery of any bonus or incentive compensation paid to an SEO based on financial information that later proves to be materially inaccurate, (3) prohibitions on making golden parachute payments, and (4) an agreement not to deduct for tax purposes executive compensation in excess of $500,000 for each SEO (Section 111(b) of EESA). The Treasury Department has issued interim final rules providing guidance under Section 111(b) of EESA, including the following:
- The duties of compensation committees with respect to incentive compensation, such as identifying “unnecessary and excessive risks,” reviewing compensation arrangements with the institution’s senior risk officer(s) and certifying their review of SEC incentive compensation arrangements
- How the recovery of bonus and incentive compensation under the CPP is broader than the clawback provision under the Sarbanes-Oxley Act (e.g., it includes all SEOs, applies to public and private companies, does not require an accounting restatement and does not contain a time-limit on clawbacks)
- What constitutes an “involuntary termination” that is subject to the golden parachute prohibitions
- How the deduction limitation agreement will apply to a CPP Participating Institution
Programs for Systemically Significant Failing Institutions (PSSFI)
EESA authorized the Secretary of the Treasury Department to establish programs to “purchase, and to make and fund commitments to purchase, troubled assets from any financial institution.” Notice 2008-PSSFI sets forth guidance for the executive compensation standards that will apply to firms that directly sell troubled assets to the Treasury Department in a negotiated transaction. These standards are substantially similar to the standards under the TARP CPP. A significant exception is that the restriction for golden parachute payments under PSSFI is much more stringent that under the TARP CPP. Specifically, any compensation that is paid by reason of an involuntary termination from employment or in connection with bankruptcy, insolvency or receivership is subject to golden parachute treatment even if the total amount of such compensation is less than three times the SEO’s average taxable compensation during the five year period prior to employment termination.